LEHMAN MOMENTS FOR CHINA…?

A sub –prime crisis of sorts is knocking at the Chinese doors because of barbarous growth in debt, poisonous levels of addiction to bank loan, and crony capitalism. Growth slowdown is bringing China tantalisingly close to labour unrest. There may not be another Tiananmen Square anytime soon but the emerging situation will see the Chinese leadership working overtime to make people turn away from domestic mess and rally behind the party flag with patriotism in full flow, says the author and argues that there was more to the stand-off China had staged at Doklam than mere diplomatic slugfest.

Lehman moment is staring at China just after it made a Himalayan climb down from its bravado at Doklam in order to host Prime Minister Narendra Modi at the Brics summit in Xiamen (Fujian Province).

Its finances are in a mess, and the society is soaked in debt with no quick fixes in sight, according to state and party controlled Chinese media and Hong Kong publications even as the outside world tends to see China’s new Silk Road fixation and offer of liberal investment as the sure signs of a gallant white knight in shining armour.

Debt has witnessed “barbarous growth”. Obsession with bank loans has reached “poisonous” levels. Young Chinese have become addicted to debt.

Ponzy schemes, pyramid schemes, zombie companies, Peer – to – Peer platforms with get rich offers are creating a Chinese maltova cocktail, more so as some victims are taking their lives in distress.

Hordes of granny gangs (women around 50 years, who abuse, stone and undress to shame) on the prowl as debt collectors are scripting a situation unfamiliar to the Communist state.

These nuggets are not hidden from public gaze at home. If they did not get the global attention they deserved it is because the West, having made China its manufacturing hub, has developed a vested interest to not look beyond the trade ties.

China has seen at least two million layoffs from “over capacity” companies in recent months as the employers either closed shop or simply disappeared without paying dues to the workers. Swelling ranks of jobless urban youth, and shrinking official labour population have pushed the social unrest quotient.

President Xi Jinping has called for a Second Cultural Revolution (to make the youth go to the country side) but has found few takers despite the promise of plenty of jobs in farming, food processing and rural tourism.

GALLOPPING DEBT

Debt is galloping in official financial market and the shadow financial system as well

About 45 per cent of China’s GDP is in the industrial economy, which after a credit-fueled growth, is suffering from debt-laden excess capacity now, says Andrew Brown of ShoreVest Capital Partners

Chinese corporate sector has become the most indebted in the world, owing an amount equivalent to 170 percent of GDP.

Others – provincial governments, non-financial businesses and households account for a debt of whopping 228 per cent of GDP, or 154 trillion Yuan (HK$179 trillion), the government-backed National Institution for Finance and Development (NIFD) said this June in the first ever public acknowledgement of China’s debt burden.

The share of local bodies and governments in debt pile is more than 20 trillion Yuans – “through legal and illegal platforms and ignoring risks as also their ability to repay”. Household debt is poised to touch 66 trillion Yuans in another three years.

CRONY CAPITALISM

Communist version of crony capitalism or what the Chinese media terms as elite capitalism, is making matters worse for President Xi, who has been making desperate attempts to avert a macro Chinese bubble.

Like in several Asian and African countries, in China also, a small group of tycoons and speculators have manipulated and milched the system.

“A gang of villains running amok”, have used privileges and power to fight for and divide financial spoils among themselves, says a Chinese economist, who has not been identified in media dispatches.

Wang Xiangwei, a Beijing based media pundit, is much more explicit and vocal in his critique.

Taking advantage of regulatory loopholes and their political connections to officials in high places, a small group of Chinese tycoons and speculators were able to “summon wind and rain” in the economy and capital markets, securing cheap loans and issuing high-risk financial products to finance their empire building at home and abroad, he wrote in the South China Morning Post on 12th August, 2017.

MONEY LAUNDERING

The Bambaoo capitalists have rewritten the rules of money laundering too.

Under the guise of heeding government’s call for “going out (investment abroad), they have moved huge amounts of money by inflating their domestic assets and then pledging them to overseas branches of the Chinese banks for loans to finance their overseas purchases.

Thus the ‘going out’ policy while helping in massive acquisition that range from enterprises to football clubs has become a pronounced fault-line, according to a recent commentary in Global Times.

This is China’s sub-prime crisis.1.0.

NEAR TERM BLUES

According to a recent dispatch in South China Morning Post (owned by Alibaba Group, a Chinese e-commerce company), expansive fiscal policy, higher government spending, a housing rally, ultra-loose monetary conditions and record bank lending besides regulatory loopholes are the root cause of unfolding financial crisis.

Way back in 2009 also, the Chinese economy found itself in doldrums. Prime Minister of the day, Wen Jiabao, prescribed a 4 trillion fiscal stimulus. It offered some badly needed relief to the economy but advent of crony capitalism has created an albatross for the Dragon.

As a Hong Kong daily noted, with a persistent slowdown, the Dragon has no alternative but to adjust its target to an achievable goal.

Between 2010 and 2015, Chinese economy, considered as the world’s second-largest, witnessed a steady slowdown, with annual (percentage) growth rates of 10.5, 9.5, 7.9, 7.8, 7.3 and 6.9, respectively. Even this growth was achieved by creating “an explosive increase in debt”.

To ward off near term blues, the Chinese leadership may give up its penchant for a headline growth rate.

The new approach fits in well with President Xi Jinping’s priority to risk controls. But it would herald growth slow down while offering a safety net to the economy, according to Hong Kong based economists, who aver that “structural reforms” of “the fraud ridden financial system” are urgently needed rather than “high growth.”

“The 6.5 per cent growth target, you can still achieve it, but at a higher and higher cost. So why would they (Chinese Govt) want to keep doing that?” Louis-Vincent Gave, co-founder of Gavekal Research, told a Hong Kong briefing. Although the move (dropping growth targets) could slow down short-term growth it could promote longer-term sustainable growth, he said.

Now Some Specifics

First about Get Rich Schemes

Get rich schemes in Communist China? Well, money has no colour and human greed is same everywhere.

These schemes do not have the official stamp but are available in Beijing and elsewhere under different categories – Ponzi schemes, Pyramid Schemes and the internet based Peer-to-Peer (P2P) lending platforms. They have since become China’s financial nightmare with their shadow credit estimated at around 16.8 trillion yuan ($2.49 trillion).

This is a gigantic credit overhang; it can be a time bomb unless focussed attention is paid to reform the social financing sector. Already duped investors are hitting the streets in protest; some are even committing suicide.

Low bank deposit rates, volatility in the stock market, and strict rules on investments abroad have pushed people to the neighbourhood Ponzi schemes.

These high return schemes adopt different tricks of trade in North and South China to lure potential clients.

While in the North these syndicates tend to use force, those in the South prefer to use brainwashing methods with ‘patriotism, opportunity and success,’ Li Xu, founder of the China Anti-Pyramid Selling Association, told the Global Times in early July.

There is no reliable data on their number. A biggest plus that makes these companies thrive is financial naivety in towns and villages across China even two decades after the financial market was opened, says Zhao Xijun, deputy dean of the school of finance at Renmin University of China.

President Xi’s government has declared a war on get rich schemes but the police have not been able to end their menace. The latest crack down on one such venture took place in the coastal city of Beihai in the Guangxi Zhuang autonomous region, China News Service reported on Aug 30, 2017.

P2P ventures were good Samaritans when they first appeared on the scene as online intermediaries to help small businesses with loans from online investors. Over time, these have degenerated into illegal activity with profit-hungry players hunting aggressively for investors and money in the markets.

Two years ago, in 2015, Ezubao, was China’s largest P2P lender. It ripped off some 900,000 investors to the tune of 50 billion Yuans in under 18 months. Its owner was a 30-something fraudster. A survey last year found that 1,598 P2P platforms, almost 40 per cent of the total P2P companies tracked, had either shut down, defaulted on repayments, or owner-managers simply vanished.

Shanxinhui (Kindness Exchange) scheme has duped tens of thousands of people of their hard earned money. It was banned after the victims took to streets in southern Beijing. Launched in 2013, the Shenzhen-based company attracted about five million members. Its offer was an irresistible 10 to 30 per cent return, and bonus payments to those who recruited additional “investors”.

Authorities in Guangdong Province arrested 230 members of Shanxinhui in July on the charge of organizing and leading a pyramid scheme, Xinhua reported. Police investigated 2,826 pyramid scheme cases last year, 19.1 percent more than the previous year.

JOB SCENE-WAVE OF LAY OFFS

Huge labour force has enabled China to become the manufacturing hub of the world and create an economic miracle at home. But layoffs are not new.

In the late 1990s, then Prime Minister Zhu Rongji closed hundreds of state factories and put millions out of work. It was part of his plan to revive the state sector in three years.

The current labour scene is no different from Zhu era; it has been triggered by growth slow down, going by media reports.

“It’s true that the size of China’s labour force has peaked, but it’s wrong to think that there will be no employment problems,” Lin Yanling, a professor with the Beijing –based China Institute of Industrial Relations, was quoted as saying.

Only 20 per cent of Chinese labour force is said to be skilled and experienced. They have job security but the concern is about the remaining 80 per cent, who are “in a weak position” in terms of capital-labour relations. “If the economic situation is not good, their position will be even weaker,” Lin said.

China is home to more than 270 million migrant workers, but only 10 per cent are covered with unemployment insurance, the government’s statistics agency said in its annual survey of migrant workers. This and the low wage syndrome haunting Chinese labour market are potential triggers for worker- related crisis

SECOND CULTURAL REVOLUTION

As pointed out at the outset, the Chinese government has hit upon the idea of a return to Maoist roots with a call for Second Cultural Revolution. Unlike in the past when the diktat forced youth to “learn from the peasants”, this time the government is seeking to convince legions of unemployed to find a new life in the countryside.

The State Council has released guidelines to local authorities to help “those having trouble making ends meet in the city or do not want an urban lifestyle,” with financing and technical assistance.

“I think the guidelines will largely stay on paper and not be practised in real life,” Wang Jiangsong, Professor at the Chinese Institute of Industrial Relations told the South China Morning Post. The move comes amidst rising labour unrest in the mainland cities, he noted.

There is no precise estimate on the number of job seekers in China. Official data about the urban jobless registration rate compiled by the labour ministry has barely changed over the years, standing at about 4.1 per cent.

The data offered by the National Bureau of Statistics is also suspect. Its surveyed jobless rate shows unemployment at 5.1 per cent. “Unfortunately, it’s hard to get a real picture of China’s job market via government data,” said Steve Wang, a China economist with Reorient Financial Markets in Hong Kong.

Put differently, the job market is destined to become grim making the workers to miss a beat.

Hundreds of thousands of people have already lost their jobs at coal mines in northeastern China to aluminium smelters in Shanxi and steel plants in Hebei.

As President Xi Jinping intensifies his battle against “zombie companies” (government-backed enterprises kept afloat by external funding), unemployment is set to rise, says a report.

This means more troubled times for workers, says the China Labour Bulletin, pointing out that incidents of worker unrest doubled in 2015 compared to 2014.

“The problem (labour unrest) is serious in manufacturing towns in the Pearl River Delta, in the rust belt of northeastern China, and the coal mine zones in north-western China,” said Tao Dong, the chief economist for non-Japan Asia at Credit Suisse.

He, however, warns against ‘exaggerating’ the risks, pointing out that services businesses in Beijing and Shanghai are in need of more hands.

“If a migrant worker is laid off from a shoe factory in Guangdong, maybe he can work as a security guard or a supermarket cashier in a big city,” Tao opines.

Not many share his optimism though.

BANK NPAs

The Chinese banks are not in pink of health. They are saddled with huge non-performing assets (NPAs).

Outstanding bad loans across the banking sector exceeded two trillion Yuan by the end of May (2016), up by 280 billion Yuan, or 14 per cent, according to banking regulator. This is the highest level of bad loans since 2004.

More than 70 of China’s most indebted companies are in steel, coal, chemical and equipment manufacturing sector and all of them are state-owned.

In a bid to bail them out, China banks converted more than 1 trillion Yuan (US$149.2 billion) of debt into stock holdings. It was the largest debt-to-equity swap in China, according to the official China New Agency.

Another NPA culprit is household debt, which has been the major driver of China’s credit growth, expanding by an average of 19 per cent a year since 2011, said Chen Long, an economist at Gavekal Dragonomics.

At this pace, Chinese household debt would reach roughly 66 trillion yuan mark by 2020 – more than double the current level.

“Other countries take decades to complete such an increase,” said Chen, and attributed the Chinese phenomenon to what he calls “loose lending standards.” This is what has made the Moody’s to raise alarm bells.

HOUSEHOLD DEBT

Massive money supply, urbanisation and a mortgage loan boom have resulted in a hefty rise in household debt, which is now equivalent to 44.4 per cent of GDP, triple the level in 2008, according to the Bank for International Settlements.

This is not very high when compared to the 79.5 per cent of GDP in the US and 62.5 per cent in Japan but it still is cause for concern because the Chinese household debt has risen “too steeply to be safe”, according to a research report by the Institute for Advanced Research at Shanghai University of Finance and Economics.

Simply put signs of “an impending crisis” are plastered all over the Chinese market place.

CORRUPTION- FUDGING

Rampant corruption and fudging of accounts have become a bane of Chinese economy. State – owned companies are faking profits. Some provinces are even falsifying economic data in a clear blow to the credibility of statistics trotted out by the Chinese government.

Bottom of Form

The Communist Party’s anti-graft watchdog, the Central Commission for Discipline Inspection, said in a statement (on 12th June 2017) that Inner Mongolia and Jilin had cooked some of their figures. It did not elaborate on the scope or time span of the falsification, though.

The revelation comes just a few months after officials in Liaoning, a rust-belt province neighbouring Jilin and Inner Mongolia, were exposed for falsifying economic data from 2011 to 2014, Frank Tang reported in South China Morning Post.

As many as 18 of the 20 state-owned firms have inflated their revenues by more than 200 billion Yuans (US$29 billion) in recent years; they also boosted their profits by 20 billion yuan with faked business and manipulated books, an audit report said this June.

China National Petroleum Corporation, China State Shipbuilding Corporation and Sinochem Group are amongst these audited worthies.

The audit report paints another bleak picture, and it is in respect of cleaning their zombie subsidiaries.

In October last year, nine of the audited firms were still having trouble cleaning up their 187 “zombie subsidiaries” – heavily indebted entities that were losing money.

For instance, China National Building Material, the nation’s largest cement producer, has failed to cut its capacity by six million tonnes as ordered. In fact, it rented 1.39 million tonnes of capacity from other companies to expand production.

PREMIUM ON CHINESE CREDIBILITY

The auditor also found that by the end of last year, three out of the 18 provinces had illegally approved production of 12.59 million tonnes of coal and 1.33 million tonnes of steel. All this at a time President Xi government was trying to buy peace with US and WTO promising that it was reducing coal capacity by 290 million tonnes and steel capacity by 65 million tonnes.

Interestingly, when Moody’s downgraded China’s rating by one notch to A1 this May saying that it has failed to reform, Beijing poured scorn over the rating agency. It also asserted that Moody’s have overestimated the risks and underestimated China’s ability to keep the situation under control.

Chinese credibility now carries a premium.

PARTY CONTROL

Since President Xi Jinping came to power, the Communist Party of China has been boosting its presence in all sectors of economy. His dictum: State -owned enterprises must answer every call from the party. It has resulted in local party unit chief’s heading the board of directors of all local state-owned companies.

An estimated 40 million people work for China’s state-owned industrial behemoths. Of them, more than 10 million are Chinese Communist Party members. And these enterprises contain more than 800,000 party committees.

Communist Party members at state enterprises form the “the most solid and reliable class foundation” for the Party to rule the country, Bottom of Form

Xiao Yaqing, director of the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), wrote in the Central Party School’s Study Times in early June.

Established in 2003, SASAC overseas 102 conglomerates that contributed 60 per cent of China’s outbound investments by the end of 2016. Its mandate is clear and simple: enhance profitability, employee loyalty and corporate governance. But problem is these titans in oil, telecom, power, weapons manufacture with assets worth 50 trillion Yuan have been mostly in the red. Their profitability is weak.

For instance, Sinosteel Corp, has failed to repay its bond holders on time since 2014, while China Cosco Holdings, the listed vehicle of Cosco, racked up losses of about 10 billion Yuan last year.

Yet, for Xiao, political loyalty is the priority for state enterprises. A clear signal that President Xi needs to re-visit his strategy board if he wants to reboot his reforms to reduce debt hang over Chinese economy. It is bound to be a painful process, more so when there are no short cuts to debt nirvana.

No surprise a Harvard University study predicts a dramatic fall in China’s economic growth to 4.41 per cent in the coming years until 2025. It however expects India to perform extremely well growing at 7.72 per cent during the same period.

“The economic pole of global growth has moved over the past few years from China to neighboring India, where it is likely to stay over the coming decade,” Harvard’s Center for International Development said in its study released in early July.

ECONOMY, PATRIOTISM AND DOKLAM

President Xi Jinping has an unenviable task.

There is no need to exaggerate the risks facing the Chinese economy. Nor the risks and fault lines be underestimated. The debt overhang is a self-inflicted wound, which has become a pestering sour because of the opaque system in place.

The big plus for Xi is that he has the mandate of the Communist Party and he has the political will to steer the economy. His highly publicised crackdown on corruption in government and the party as also on private business tycoons and the mushrooming private lenders shows his resolve to come to grips with the issue without much ado.

This enterprise is leaving a negative impact on the Chinese society. In the days ahead it can become more pronounced because the pundits are saying: “Prepare for Pain” while reining in “grey rhinos of economic risk.”

The prognosis does not mean that curtains are set to go up on another Tiananmen Square anytime soon. But the emerging situation is such that the Chinese leadership must make people turn away from domestic mess and be focused to rally behind the party flag.

Only a threat to the integrity and sovereignty of the country can become a rallying point. Patriotism has no premium. It offers a glue to stick together with no other thought.

Who could fit the bill of Enemy Number One for China?

Not the countries in the South China Sea; they have already bought peace even after winning their share of rights over the SCS waters.

Not the United State of America, USA. It is too dependent on Chinese economy to severe the Sino-US ties. Chinese goods and services have become an integral component of every day American life. Bilateral trade at $519 billion in 2016 has made the two countries each other’s largest trading partner.

Not the Japanese either whatever be the pinpricks and word play and fare-ups over the Senkaku Islands.

Russia is a friend and partner that the Chinese have come to trust. Moscow loved to ignore Chinese efforts to malign India in the past; it may do so now and in the future too. So what?

This leaves India with which China has a long border dispute. Both have not seen eye-to-eye on a host of issues that range from India’s membership of Nuclear Supplier Group to UN’s terrorist tag for Masood Azhar and cross border terrorism enterprise Pakistan has perfected with Saudi money and American weapons.

And we get the key to solve the Doklam Sudoku.

Daily dose of bellicose rhetoric was no more than chest thumping designed to make the enemy to wince – in pain, disgust, and regret in equal dose.

For 73 –days, Global Times and People’s Daily have had a field day with war noises, threats and homilies to India in the most undignified manner; Beijing has made everyone to believe that its media has become a free enterprise to kick India around

And Doklam face off appeared to have the potential to achieve the objective with “psychological warfare, media warfare and lawfare” in action in full world view.

Yet, the plan misfired. Why?

Firstly because China factored in dated theories, like, for instance, India is a country of colour and chaos. Secondly it remained in 1962 mindset forgetting that 1962 has become history long ago.

Beijing was stumped therefore when India waited out, willingly and patiently offering no military clash.

Even a skirmish of limited nature could have provided the opening China was looking for. Delhi denied that as well.

In recent years, China has been increasingly resorting to “coercive, assertive practices” to achieve its goals in the Asia-Pacific region.

The Chinese also want to make the regions more Sino-centric, “where China can prevail and can essentially compel other nations in the region to put China’s interest first and show deference to China” as Sinologist Bonnie Glaser (senior adviser for Asia and the director of China Power Project, Centre for Strategic and International Studies) says. In her world view the Chinese have begun to dream like the 12 and 13 century of Ming Dynasty.

Glaser may be right or wrong or both. What neither she nor the Chinese did not realise is the distance India has travelled over the past 55-years.

Result, China found itself with no choice except to “make a Himalayan climb down and open talks”, as the Wall Street Journal (WSJ) said. Rest is history with or without a face saver in place.

REFERENCES

China seeks to convince legions of unemployed to start afresh in the countryside. Report in South China Morning Post, Dec 1, 2016 http://www.scmp.com/news/china/policies-politics/article/2050547/china-seeks-convince-legions-unemployed-start-afresh

China declares war on get-rich schemes, citing risk of social unrest: by Jane Cai in South China Morning Post, July 25, 2017 http://www.scmp.com/news/china/economy/article/2103926/china-declares-war-get-rich-schemes-citing-risk-social-unrest

Will China’s consumer market become the next credit bubble: by Andrew Brown in SCMP, Aug 4, 2017 http://www.scmp.com/business/money/money-news/article/2105445/will-chinas-consumer-market-become-next-credit-bubble

China returns to form – micromanaging overseas investments – but purchases rise, anyway: by Tom Holland in The SCMP, July 31, 201 http://www.scmp.com/week-asia/opinion/article/2104449/china-returns-form-micromanaging-overseas-investments-purchases

How the Communist Party controls China’s state-owned industrial titans: By Wendy Wu in SCMP, June 17, 2017 http://www.scmp.com/news/china/economy/article/2098755/how-communist-party-controls-chinas-state-owned-industrial-titans

Two more Chinese provinces found faking economic data: By Frank Tang in SCMP, June 12, 2017 http://www.scmp.com/news/china/economy/article/2098007/two-more-chinese-provinces-found-faking-economic-data

Global barometer: analysts take their cue from China’s GDP growth figures: By John Cremer in SCMP, May 22, 2017 http://www.scmp.com/special-reports/business/topics/private-banking/article/2095204/global-barometer-analysts-take-their

Billionaire Wu’s detention signals China’s clean-up of financial sector is in full swing: By Wang Xiangwei in South China Morning Post, June 17, 2017 www.scmp.com/week-asia/opinion/article/2098421/billionaire-wus-detention-signals-chinas-clean-financial-sector

The three government numbers China’s economists trust least : by Jane Cai in The South China Morning Post, June 16, 2017 http://www.scmp.com/news/china/economy/article/2098730/three-government-numbers-chinas-economists-trust-least

China declares war on get-rich schemes, citing risk of social unrest: By Jane Cai in South China Morning Post, July 25, 2017. www.scmp.com/news/china/economy/article/2103926/china-declares-war-get-rich-schemes-citing-risk-social-unrest

Can Xi Jinping head off the grey rhinos in China’s economy? By Wang Xiangwei in South China Morning Post, Aug 12, 2017 http://www.scmp.com/week-asia/opinion/article/2106257/can-xi-jinping-head-grey-rhinos-chinas-economy

China exposes US120 million local government debt scandal: By Frank Tang in South China Morning Post, July 1, 2017 . http://www.scmp.com/news/china/economy/article/2100851/china-exposes-us120-million-local-government-debt-scandal

Xi Jinping goes all out to rid China of poverty in three years:Report in South China Morning Post, Sept 1, 2017 http://www.scmp.com/news/china/policies-politics/article/2109246/we-must-send-our-best-front-line-xi-jinping-goes-all

Drought in Northern China Is Worst on Record, Officials Say: By Edward Wong in The New York Times, June 29, 2017 https://www.nytimes.com/2017/06/29/world/asia/china-drought.html?rref=collection%2Fsectioncollection%2Fasia